There’s a set of indicators mainly concerned with predicting when a trend might be coming to its end, rather than catching a signal of its beginning.

The important concept here is whether the market is overbought/oversold or not. We’re trying to get an idea of market momentum, so these are momentum indicators.

Momentum
With an uptrend, originally, the price was seen as cheap – so there were a lot of buyers in the market – which drove the price up – to a point where it got too expensive to buy – so sellers start to enter the market – and the rise in the price stops, reaching a level, or reversing.

Or look it this way (and maybe notice how the forex market and the ordinary stock market work slightly differently here). At some point in a trend, people get to wanting to cash up and go home – the momentum has gone out of the market. They close their trades and take their profits. Whichever way the trend was, it’s finished now – and the market is overbought if it was an uptrend, and oversold if it was a downtrend.

Stochastic indicators
Stochastic, fancy word, roughly meaning a process subject to both predictable and random elements.

Usually two stochastic oscillator indicators are plotted, fast (%K) and slow (%D) indicators. What we won’t do here is any of the math – it’s available out there, if you want to have a look, but here is just going to slow us down.
What we end up with is a pair of lines oscillating between 0 and 100, as shown:

Signals
From the chart you can see that the movements of the indicators coincide with the various up and down trends.

Stochastic indicator above 80 = overbought
Stochastic indicator below 20 = oversold
(Some traders and some books on the subject will apply the same principles to 70/30)

So, in practice, a trader will be watching for the indicator to go over 80, for example, and then start to reverse, dropping back below the threshold. At this point, the price should also be beginning to fall, suggesting that a downtrend is established, bringing the market back from its overbought state – that’s when to start putting your money into the market and go short.
And the converse for the stochastic indicators dropping below 20 and then beginning to rise again… go long.

There are other signals to be gained from these indicators – for example, when the fast and slow stochastics cross over each other – these are a little more complicated for the forex beginner.

There are several other indicators in this family that are regularly used to do a similar job,
for example, RSI, the Relative Strength Index, also Parabolic SAR – which of these you might choose to use on a forex chart can often be a matter of personal preference and prejudice…

Let’s go on to look at 11. Pivot Points →